These 4 Measures Indicate That Chongqing Zhifei Biological Products (SZSE:300122) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Chongqing Zhifei Biological Products Co., Ltd. (SZSE:300122) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Chongqing Zhifei Biological Products

What Is Chongqing Zhifei Biological Products's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Chongqing Zhifei Biological Products had CN¥9.06b of debt, an increase on CN¥4.30b, over one year. However, it also had CN¥3.26b in cash, and so its net debt is CN¥5.80b.

A Look At Chongqing Zhifei Biological Products' Liabilities

According to the last reported balance sheet, Chongqing Zhifei Biological Products had liabilities of CN¥21.6b due within 12 months, and liabilities of CN¥618.9m due beyond 12 months. Offsetting this, it had CN¥3.26b in cash and CN¥21.4b in receivables that were due within 12 months. So it actually has CN¥2.40b more liquid assets than total liabilities.

This short term liquidity is a sign that Chongqing Zhifei Biological Products could probably pay off its debt with ease, as its balance sheet is far from stretched.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Chongqing Zhifei Biological Products has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 141 times the size. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Chongqing Zhifei Biological Products if management cannot prevent a repeat of the 59% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Chongqing Zhifei Biological Products can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Chongqing Zhifei Biological Products created free cash flow amounting to 20% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Chongqing Zhifei Biological Products's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Chongqing Zhifei Biological Products's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Chongqing Zhifei Biological Products is showing 3 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.